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The Role of Risk in the Investment Decision Process: Traditional vs Behavioural Finance

In: Risk Tolerance in Financial Decision Making

Author

Listed:
  • Camilla Mazzoli
  • Nicoletta Marinelli

Abstract

Risk and uncertainty exist whenever the future is unknown (Williams et al., 1997). Despite the intuitiveness of the concept, risk and its definition are still a debated issue in the literature. A first point to be discussed is the difference between risk and uncertainty. Knight (1921) maintains that risk refers to a situation for which the possible outcomes and their probabilities are known (measurable uncertainty); on the contrary, uncertainty exists when the probabilities associated to the outcomes are not known (unmeasurable uncertainty). In any case, not all academic authors agree on this distinction. Levy and Sarnat (1995) point out that, if one considers the existence of a subjective probability according to Savage (1954), the distinction between risk and uncertainty disappears. In fact, by assigning an individual subjective probability to decision problems, an uncertain situation can be transformed into a risky choice1 and the distinction loses significance.

Suggested Citation

  • Camilla Mazzoli & Nicoletta Marinelli, 2011. "The Role of Risk in the Investment Decision Process: Traditional vs Behavioural Finance," Palgrave Macmillan Studies in Banking and Financial Institutions, in: Caterina Lucarelli & Gianni Brighetti (ed.), Risk Tolerance in Financial Decision Making, chapter 1, pages 8-66, Palgrave Macmillan.
  • Handle: RePEc:pal:pmschp:978-0-230-30382-9_2
    DOI: 10.1057/9780230303829_2
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    Cited by:

    1. Anzel van den Bergh-Lindeque & Sune Ferreira-Schenk & Zandri Dickason-Koekemoer, 2021. "Individual Investor Risk Tolerance from a Behavioural Finance Perspective in Gauteng, South Africa," International Journal of Economics and Financial Issues, Econjournals, vol. 11(4), pages 53-65.
    2. Sune Ferreira-Schenk & Zandri Dickason-Koekemoer & Naveed Hussain Shah, 2021. "Factors Influencing Individuals Short-term Investment Intentions," International Journal of Economics and Financial Issues, Econjournals, vol. 11(4), pages 73-81.
    3. Rodríguez, Yeny E. & Gómez, Juan M. & Contreras, Javier, 2021. "Diversified behavioral portfolio as an alternative to Modern Portfolio Theory," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).

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